Australian banks face five key challenges warns Moody's

Credit ratings agency Moody's has warned Australian banks are facing a "growing number of headwinds" as interest rates remain persistently low, and banks stay sensitive to potential shocks.

"These headwinds could, over time, put pressure on the credit profiles of Australia's major banks, particularly in the context of their very high ratings," said Frank Mirenzi, a Moody's vice president and senior analyst.

"Whilst solvency and liquidity buffers have improved in recent years, the path of future balance sheet strengthening is likely to be slower than in previous years - at a time when risks continue to rise," he said.

Moody's said it expects the Reserve Bank of Australia's historically low policy rate of 1.75 per cent to persist over the next 12 months.

In its report titled "Australian Banks: Rising Leverage and Cyclical Challenges Pose Risks", Moody's said it expects the banks' interest margins and profit growth to come under downward pressure, listing five main increasing challenges.

1. A longer period of low interest rates

With inflation at 1.3 per cent, well below the Reserve Bank's target range of 2 to 3 per cent, Moody's flagged that one or more further interest rate cuts seem likely.

"Our outlook for a longer period of interest rates in Australia is credit negative for banks, reflecting a weaker operating environment," the report said, adding that bank profitability would be pressured from the low interest rates, while weaker profitability could slow the growth of any loss absorbing buffers.

Moody's said that, while overall conditions in labour markets remain favourable, that situation has led to rising underemployment which is higher than the long-run average dating back to the 1990/91 recession.

"This development has the potential to stretch household finances further and reduce household financial flexibility," the report warned.

5. Unwinding of global commodities cycle

"We expect loan impairment metrics of Australian banks to normalise over the next 12-18 months at a level closer to, but still below, the long-run historical average," the report said, adding direct exposure to the resources sector is relatively low.

In regions most exposed to mining, including Western Australia and Queensland, Moody's said there are signs of stress in sectors including resources-related services and commercial real estate.

Despite risks, bank fundamentals 'strong': Moody's

Despite these risks, Moody's flagged that the Australian banking system still operates in an economy with a "very high degree of economic resilience as well as institutional government financial strength".

"Although the economy is undergoing a transition from resources investment-led growth to other sources of growth, it has so far proven resilient," the report said.

"As a result the banks have thus-far demonstrated profitability and exceptionally strong asset quality with a better-than-average problem loans ratio relative to their global peers."